Look one more time at Table 3.5.

a. Suppose you knew the bond prices but not the spot interest rates. Explain how you would calculate the spot rates.

b. Suppose that you could buy bond C in large quantities at $1,040 rather than at its equilibrium price of $1,076.20. Show how you could make a zillion dollars without taking on any risk.

TABLE 3.5

Year (t) Bond Price (PV) Yield to Maturity (y,%) 4 Spot rates 0.03 0.04 0.05 0.06 Discount factors 0.9709 0.9246 0.8638 0.7921 Bond A (8% coupon) Payment (C) $80.00 1,080.00 PV (C) 77.67 998.52 $1,076.19 3.96 Bond B (8% coupon) Payment (C) $80.00 80.0 1,080.00 $77.67 7396 932.94 PV (C) $1,084.58 4.90 Bond C (8% coupon) Payment (C) 0.00 80.00 80.00 1,080.00 $77.67 73.96 PV (C) 69.11 855.46 $1,076.20 5.81